Chamath Palihapitiya: It may take three years for the market to “accurately” reprice late-stage cos

by Ana Lopez

Former Facebook exec turned VC Chamath Palihapitiya has long been a controversial figure in the investment world. Both brilliant and belligerent, Palihapitiya became most famous for ushering in the era of special acquisition companies, or SPACs, starting in the fall of 2019 when he helped Virgin Galactic become a publicly traded company through a SPAC he founded.

Palihapitiya went on to disclose five more companies through SPACs before the boom came to an abrupt end last year, and as investors who followed him in some of his SPACs lost money – as did investors in many hundreds of other SPACs that closed in 2020, 2021 and last year – Palihapitiya reportedly doubled the approximately $750 million he invested.

Many blame him for aggressively promoting his own interests – including during countless CNBC appearances – at the expense of less experienced investors. Others continue to heed his investment advice, as Palihapitiya seems adept at identifying investment opportunities early on. (This editor recalls his 2014 appearance at a packed bitcoin conference in San Francisco, where he argued that everyone should have 1% of their wealth in Bitcoin. At the time, each Bitcoin was valued at $520.)

Both camps may be interested in a recent appearance by Palihapitiya at a conference on investing in Miami, where he said he thinks up to seven years of high interest rates would be good for the venture industry, that America’s deteriorating relationship with China is a boon for the country, and where he talked about generative AI and where he thinks that the real money will be made. It’s worth a read if you have a few minutes. His remarks have been shortened for length and clarity. You can watch the full interview here.

On the impact of higher interest rates:

[The tech industry] actually counterintuitively built better businesses during periods of high rates because there are fewer allocators coming to our part of the market because [investors] find better risk-free rates [elsewhere]. And in the absence of this excess of capital, it forces every single company to just be better managed. So as an ecosystem we become more intolerant of excess, and that makes for better managed businesses, and we probably haven’t had that cycle in 14 or 15 years, and we desperately need it.

There are some dirty little secrets [in the venture industry]. One is that only 10% of all companies in our asset class actually generate real returns, meaning 90% are essentially floundering around and burning money. The other thing is we’ve always consistently generated a high single-digit DPI [a term used to measure the capital a fund has returned thus far to its investors] — 1.7x is similar to the 30-year average — yet we are the worst offenders when it comes to showing [the institutional investors who fund VCs] paper markers or TVPI [which represents both realized profits and unrealized future profits]. So there’s a dance that this industry has been able to play because rates were at zero [but] as investors, the asset class is challenged to generate real returns [because the companies we have funded] are, because of all this excess capital, under-managed than usual, so we need to correct course. We need these rates to last 5, 6, 7 years, frankly, hopefully, to really flush it down the system.

On what Palihapitiya now thinks of crypto, SPACs and other innovations that investors have plunged into between 2018 and more recently:

Start-up business, largely in healthcare and software and deep tech and recently energy transition – that’s been our bread and butter. But we sometimes go a little off-piste. In early 2011, I went off-piste and made a huge bet on Bitcoin when it was $80 a coin. It just seemed like an incredibly huge risk reward. We did the same thing in the mid-2000s; we did it in SaaS and in deep tech.

[With] SPACs, we came across this thing because we wanted to raise money for some of our businesses that were extremely capital intensive, and we demonstrated something that caught a lot of wind in an instant. We’ve done six. I think there were 650 in 2021 alone, so us [represented about] 1% of the market. I think we bought good companies; I think we sold well, honestly. But it’s one of those things where it was fueled by a moment in time of just massive excess liquidity. And now I think we’re kind of back to basics. So for us as an institution, we’re kind of back to an early stage venture. . . . I’m the biggest LP in my fund, so if there’s an opportunity, I go for it. And that was a moment where we tried to move forward.

On what he is currently making of the later stage market:

At the end of last year I was looking at six or seven [convertible notes]. These were all extremely well-known companies that you would all know by first name, and they all came to me to recruit converts. And I said, ‘Well, here’s the real market price of these companies’, and none of them took my money. And instead they did a convert to basically deflect and kick the can down the road in appreciation.

So we’re at that point in the market where all the boards of these private companies are refusing to budge on the valuation. And the reason is that it has a significant impact on their DPI or their TVPIs that they gave to LPs. And so right now it’s a really hard part of the private markets to invest in because you’re not allowed to do real price discovery because nobody wants to take the real hits.

The best companies will do it. You’ve seen Streep [do it]. That’s probably the best technology company in Silicon Valley that’s currently being built. Klarna did. The through line there is Sequoia, which is an extremely disciplined and incredible organization; they are able to enforce that discipline. But other companies, other venture capital funds, don’t want to watch TVPI decline. . . . [so] we continue to over-index in the early stage and do as many good deals as we can see, dropping the chips where they can.

. . . . Because now this is just money bad. And when [more venture] people exit the market, those companies now become more inclined to be accurately repriced. . . [But] I honestly think it’s another three years. I thought it would be three quarters. In the beginning, when we thought about how much capital we’re really going to allocate in the next period, we cut it by two-thirds because we just didn’t see the opportunities in the late stage anymore.

How he feels about America’s deteriorating relationship with China and the associated technology bans being brought forward:

It’s an incredible blessing for America. And it’s an incredible boon for the US technology sector. The thing is, if you look in China, they’re extremely good at process engineering. They are also extremely good at additive manufacturing. They’re extremely good at things like specialty chemicals, but if you think about the precursors, all those things come from US, European, Australian companies that now have tremendous incentive to diversify that supply chain outside of China, [and that] greatly benefits American companies.

China’s answer is [so far] muted. So, for example, we said, “We’re going to slow down the flow of extremely advanced semiconductor manufacturing equipment to China,” and China’s response was, “We’re not going to allow you to get the input components for certain silicon wafers that have been used in PV cells.” I mean, if you had to rank these things, no offense, but we can make solar cells. The equipment you need to get chip design to the two nanometer scale comes from the Dutch, Germans and Americans.

On ChatGPT and the generative AI craze more broadly:

What ChatGPT shows you is simply the amazing value computers can help you do your job. It is like a calculator that replaces the abacus and replaces pen and paper. [But a] friend of mine told me this [Warren Buffett quote] yesterday, which I love. He told the story about refrigeration and the story he tells is that the people and the person who invented refrigeration made some money. But most of the money was made by Coca Cola, which used refrigeration to build an empire. And I think of these big language models as cooling. Will it make some money? I think so. But the “Coca Cola” has yet to be built. And those are the companies that are going to make real money with it.

Here’s a basic thing about machine learning that’s worth knowing: If you take 1000 of the same inputs and give them to Facebook and Microsoft and Google and Amazon, they’re all going to come up with the same machine learning model. But if you have one extra thing, one little ingredient that all those other companies don’t have, your output can be very different. It’s like giving two great chefs three ingredients; if you give a third chef an extra, that person can do something really special. So right now we’re in the world where everyone is searching the open web, [but] we’re moving into a world where if everyone gets advanced enough, when refrigeration is widely available, someone will say, ‘You know what? This site? I’m not going to give anyone else access; it’s just me for my models.’ And those models will get better. We need to let that play out a bit.

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